Devoted to Appellate Law and Practice Within the Sixth Circuit and Its Constituent States

Thursday, August 23, 2007

A rare event. An uncommon or unusual occurrence. Isolated. Extraordinary. Virtually unheard of. Once in a blue moon.

All of these terms accurately describe the Sixth Circuit's en bancdecision filed on August 21 in Mikulski v. Centerior Energy Corp., et al., Case No. 03-4486. The Court held by an 8-5 majority (Judge Cook was recused) that state law claims for fraudulent tax accounting and breach of contract that turn on the interpretation of a provision of the Internal Revenue Code do not state a "substantial federal question" supporting the exercise of federal removal jurisdiction under the Grable doctrine despite the presence of the embedded federal issue. In so doing, the en banc Court affirmed the decision of a divided panel, 435 F.3d 666 (6th Cir. Jan. 26, 2006), rehearing en banc granted, opinion vacated Apr. 26, 2006.

In the absence of diversity, a civil action filed in state court may be
removed to federal court only if the claim is one "arising under"
federal law. Beneficial National Bank v. Anderson, 539 U.S. 1
(2003), citing 28 U.S.C. 1441(b). Whether a claim arises under federal
law must be determined by applying the "well-pleaded complaint" rule. Caterpillar Inc. v. Williams,
482 U.S. 386, 392 (1987). Thus, a claim "arises under" federal law for
jurisdictional purposes only if the plaintiff's statement of his own
cause of action on the face of his properly-pleaded complaint
affirmatively shows that it is based upon federal law. Beneficial National Bank, 539 U.S. at 7; Caterpillar, supra. However, the "substantial federal question" doctrine is a recognized exception to the well-pleaded complaint rule. It deals with the thorny issue of whether federal "arising under" jurisdiction attaches to state law claims that raise accompanying questions of federal law.

In its recent comprehensive treatment of the substantial federal question doctrine, Grable & Sons Metal Products v. Darue Engineering, 545 U.S. 308 (2005), the Supreme Court reaffirmed the principle that a state-law claim for relief which "necessarily raise[s] a stated federal issue" will confer federal-question jurisdiction (originally under 28 U.S.C. 1331 or on removal pursuant to 28 U.S.C. 1441) only where the federal issue is "actually disputed and substantial" and only where a federal forum may entertain it "without disturbing any congressionally-approved balance of federal and state judicial responsibilities." Thus, even where a state action contains a contested and substantial federal question, "the presence of a disputed federal issue and the ostensible importance of a federal forum are never necessarily dispositive." Instead, federal jurisdiction should be exercised "only if [it] is consistent with congressional judgment about the sound division of labor between state and federal courts governing the application of section 1331." But no federal jurisdiction exists, even if the disputed issue of federal law is deemed to be "substantial," where its exercise would "herald[] a potentially enormous shift of traditionally state cases into federal courts."

Grable sets forth a three-part conjunctive test for removal jurisdiction based on the presence of a federal issue in state-law claims for relief. A state-law claim can give rise to federal question jurisdiction only if:

1. the "state-law claim necessarily raise[s] a stated federal issue";

2. the federal issue must be "actually disputed and substantial"; and

3. the exercise of federal jurisdiction would not "disturb[] any congressionally-approved balance of federal and state judicial responsibilities" nor herald a "shift of traditionally state cases into federal courts."

Grable, 545 U.S. at 314, 319. Even before Grable, the Sixth Circuit had consistently held that federal questions raised by state law claims must be substantial to support federal removal jurisdiction. In the immediate aftermath of the Supreme Court's decision in Merrill Dow Pharmaceuticals, Inc. v. Thompson, 478 U.S. 804 (1986), the Sixth Circuit held in Miller v. Norfolk & W. Ry. Co., 834 F.2d 556, 562 (6th Cir. 1987), that the alleged violation of "a federal statute as an element of a state cause of action may or may not raise a substantial federal question depending upon the nature of the federal interest at stake in the case." In order to support jurisdiction, the "federal interest at stake" must have "great significance." More recently, in order to confer jurisdiction, the Sixth Circuit required the federal question raised by a state law complaint to be "substantial, disputed and of great federal interest," and the resolution of such federal question to be "necessary" to the resolution of the state law claim. Long v. Bando Mfg. of America, Inc., 201 F.3d 754, 757-59 (6th Cir. 2000).

Thus, in accordance with the reasoning of Miller and Long v. Bando, "the mere presence of a federal statute as an element of the complaint does not necessarily confer jurisdiction under the [substantial federal question] doctrine." Mikulski v. Centerior Energy Corp., 435 F.3d 666, 676 (6th Cir. 2006)(panel decision vacated by grant of rehearing en banc), citing Long v. Bando and Miller.

The Supreme Court similarly emphasized in Grable the "commonsense notion that a federal court ought to be able to hear claims recognized under state law that nonetheless turn on substantial questions of federal law," because doing so justifies "resort to the experience, solicitude, and hope of uniformity that a federal forum offers on federal issues." 545 U.S. at 312. This does not mean, however, that the "mere need to apply federal law in a state-law claim will suffice to open the 'arising under' door." Id. at 313, discussing and limiting Smith v. Kansas City Title & Trust Co., 255 U.S. 180, 199 (1921). The question whether to exercise federal-question jurisdiction over a state-law action raising an embedded federal issue "calls for a 'common-sense accommodation of judgment to [the] kaleidoscopic situations'" in which such federal issues can be presented -- which the Court described as "'a selective process which picks the substantial causes out of the web and lays the other ones aside.'" Id., quoting Gully v. First National Bank in Meridian, 299 U.S. 109, 117-18 (1936).

Thus, the Supreme Court refuses to "treat[] 'federal issue' as a password opening federal courts to any state action embracing a point of federal law." 545 U.S. at 314. Instead, "federal jurisdiction demands not only a contested federal issue, but a substantial one, indicating a serious federal interest in claiming the advantages thought to be inherent in a federal forum." Id. at 313, citing Chicago v. International College of Surgeons, 522 U.S. 156, 164 (1997); Merrill Dow, supra, 478 U.S. at 814 & n.12; Franchise Tax Bd. of Calif. v. Construction Laborers Vacation Trust, 463 U.S. 1, 28 (1983).

Moreover, the Court in Grable explicitly held that "the presence of a disputed federal issue and the ostensible importance of a federal forum are never necessarily dispositive" of federal jurisdiction. There must always be an assessment of whether exercising federal jurisdiction in a case would upset the federal-state line drawn or assumed by Congress. This is so because "the appropriateness of a federal forum to hear an embedded issue can be evaluated only after considering the 'welter of issues regarding the interrelation of federal and state authority and the proper management of the federal judicial system.'" 545 U.S. at 314, quoting Franchise Tax Board, supra, 463 U.S. at 8.

Therefore, even if an embedded federal issue in a state-law claim for relief were deemed to constitute a "substantial" federal question under the Grable test, it qualifies for a federal forum "only if federal jurisdiction is consistent with congressional judgment about the sound division of labor between state and federal courts governing the application of section 1331." Id. at 313-14.

Less than a month after the January 2006 panel decision in Mikulski, the Sixth Circuit again applied the Grable factors to hold that federal removal jurisdiction did not exist over a state-law retaliatory discharge claim alleging that the plaintiff's discharge violated public policies based on federal statutes. In Eastman v. Marine Mechanical Corp., 438 F.3d 544, 552 (6th Cir. 2006), the Court cited the fact that Congress had withheld a private right of action from the federal statutes identified in the plaintiff's complaint "as an important signal to its view of the substantiality of the federal question involved." The Court concluded that the reference to federal statutes in the complaint did not create a substantial federal question. Id. at 553. Even more importantly, the Sixth Circuit in Eastman found that accepting jurisdiction over the state-law employment suit "would be disruptive of the sound division of labor between state and federal courts envisioned by Congress." In contrast to Grable where the Court saw little danger in accepting jurisdiction because it would "portend only a microscopic effect on the federal-state division of labor" (545 U.S. at 315), the Sixth Circuit concluded that accepting jurisdiction "would distort the division of judicial labor assumed by Congress under section 1331." Id., quoting Grable.

A year after Grable, the Supreme Court confirmed in Empire HealthChoice Assurance, Inc. v. McVeigh, 547 U.S. __, 126 S.Ct. 2121, 2136-37 (2006), that the Grable doctrine had created only a "special and small category" of federal jurisdiction. The Court sharply distinguished McVeigh from Grable -- "[t]his case is poles apart from Grable" -- and dramatically limited the scope and application of Grable's holding and rationale. In contrast to Grable, which centered on whether the actions of a federal agency (the IRS) had violated a federal statute (section 6335 of the Internal Revenue Code), and presented a nearly "pure issue of law" the resolution of which would be both dispositive of that case and controlling in numerous other tax sale cases, Empire's state-law reimbursement claim arose from the actions of private litigants in a state court forum rather than from the acts of any federal agency, service or department, and were "fact-bound and situation-specific." The Court in McVeigh did not think "a proper 'federal-state balance' would place [the state-law issue] under the complete governance of federal law, to be declared in a federal forum." It held that "[t]he state court in which the [tort] suit was lodged is competent to apply federal law . . . and would seem best positioned to determine" the state law issues arising out of the state tort action. Although the Court recognized that the Government had a legitimate interest in protecting the federal workforce, it concluded that those interests did not warrant turning a straightforward state law contract claim into a costly "federal case." The Court in McVeigh summed up its holding and the proper interpretation and application of Grable as follows:

Grable emphasized that it takes more than a federal element "to open the 'arising under' door." This case cannot be squeezed into the slim category Grable exemplifies.

126 S.Ct. at 2137.

The sole federal issue in Mikulski -- whether FirstEnergy Corp. violated the effective date provision of Section 312(n)(1) of the Internal Revenue Code -- arises from the company's alleged false reporting to its shareholders that they had received taxable dividends when, in fact, the shareholders had merely received the tax-free return of their own capital. The complaint in Mikulski alleges that FirstEnergy's predecessor and its two electric-utility subsidiaries employed fraudulent tax accounting practices to manipulate their corporate "earnings and profits" in order to make the companies look more profitable than they really were. As a result, the complaint accuses FirstEnergy of misinforming its shareholders that they had received more taxable dividend income than they actually had. The measure of the alleged damages is the amount by which the shareholders overpaid their federal and state income taxes for the years in question.

As of December 31, 1984, FirstEnergy's subsidiaries had spent over $1.5 billion on "construction in progress" -- i.e., construction costs for nuclear power plants and other facilities begun during the preceding decade but still unfinished. Beginning with the 1985 tax year, corporations were required by Section 312(n)(1) of the Internal Revenue Code to capitalize their "construction period" interest expenses -- i.e., to include in the corporation's "earnings and profits" the amount of interest expense that could have been avoided if the amount spent on "construction in progress" after the effective date of Section 312(n)(1) had instead been used to reduce debt and avoid paying interest.

FirstEnergy included in its "earnings and profits" for 1985 and subsequent years the amount of interest expense (approximately $150 million per year) that it could have avoided if the $1.5 billion spent on "construction in progress" in 1984 and prior years had instead been spent on reducing its debt. Section 61(e)(1)(A) of Pub. L. 98-369 (1984) provides that the requirements of Section 312(n)(1) apply to "amounts paid or incurred in taxable years beginning after September 30, 1984." This effective date provision means that no construction expenses incurred before January 1, 1985 could be capitalized or considered in calculating a corporation's "earnings and profits." FirstEnergy's alleged violation of the effective date of Section 312(n)(1) is the only federal issue involved in the state law claims for fraud and breach of contract alleged in the complaint.

Interestingly, Section 312(n)(1) does not apply to corporate "earnings and profits" calculations for years after 1986 because Section 263A of the Internal Revenue Code, enacted as part of the Tax Reform Act of 1986, requires the capitalization of interest expense to arrive at taxable income, eliminating the necessity of adjusting "earnings and profits" by the amount of avoided construction-period interest under Section 312(n)(1) for expenses incurred in years after 1986. If costs are required to be capitalized under another Code provision, Section 312(n)(1) is not applicable. Von Lusk v. C.I.R., 104 T.C. 207, 220 (1995).

Considering the first component of the tripartite Grable test, the Court in Mikulski had "little difficulty in concluding that there is a federal issue and it is actually disputed." The second part, the substantiality of the federal interest, required a somewhat lengthier analysis. The Sixth Circuit identified four aspects affecting the substantiality of a federal interest or issue raised by state-law claims for relief: (i) "whether the case includes a federal agency, and particularly whether that agency's compliance with [a] federal statute is in dispute, (ii) whether the federal question is important (i.e., not trivial), (iii) whether a decision on the federal question will resolve the case (i.e., the federal question is not merely incidental to the outcome, and (iv) whether a decision as to the federal question will control numerous other cases (i.e., the issue is not anomalous or isolated)." (Slip op. at 12, citing Grable, 545 U.S. at 313, and McVeigh, 126 S.Ct. at 2137.) After analyzing each of the four factors separately and then considering them in the aggregate, and "acknowledging two unassailable truths -- (1) that state courts are fully competent to decide this question, and (2) that section 312(n)(1) does not control the collection of the plaintiffs' personal income taxes directly," the Court held that the federal interest in the issues presented were not so substantial as to compel or support a finding that the "traditional" state-law fraud and breach of contract claims alleged in this case actually "arise under" federal law, at least not without some express congressional determination to that effect. (Id. at 14.) Even a significant federal interest is not automatically "substantial" in the jurisdictional sense as defined by prevailing Supreme Court precedent. As the Court concluded: "If a case could be deemed to 'arise under' federal law . . . any time the litigation involves the interpretation of a provision in the federal tax code, then [prior Supreme Court] precedents -- particularly Grable -- would be meaningless . . ." Neither Congress nor the Supreme Court "intended such an expansive or limitless view of federal jurisdiction." (Id. at 15.)

Addressing the third and final Grable element, the Sixth Circuit found that "the exercise of jurisdiction over this type of lawsuit would impermissibly disrupt the congressionally-approved balance of federal and state judicial responsibilities." (Id.) But the Court sounded a cautionary note on resort to a "floodgates" argument: "While we ultimately conclude that the possibility of encumbering the federal courts with these tax-code-related cases appears both real and significant . . . , we are at pains to avoid overstating our position. We eschew predictions of any extreme outcome that may lurk in such phrases as 'flood of litigation' or 'overwhelm the federal courts,' and we have not succumbed to some eschatological trembling." (Id.)

Biblical references aside, the Court concluded that if it "allow[ed] the present dispute over a relatively obscure provision of the tax code to be pursued in federal court," it would "extend federal jurisdiction not only to the question raised in this case, but to any dispute over the meaning or effect of virtually any provision in the entire federal tax code." (Id.) Finding a substantial federal question in this case "would open the door of the federal courts to significantly more than the solitary case asserting a constitutional challenge, as in Smith [v. Kansas City Title & Trust Co., supra], or the 'microscopic effect' portended by the quiet title action in Grable. . . [E]ven if the actual number of cases proved not to be overwhelming, or even uncomfortably burdensome, it appears unlikely that Congress -- through its silence -- intended to open the federal court door quite so wide." (Id. at 16.)

On en banc review, the Sixth Circuit upheld by a 13-0 vote the unanimous panel decision that (i) Section 7422 of the Internal Revenue Code does not preempt the plaintiffs' state law claims for fraudulent misrepresentation and breach of contract, and (ii) that the district court erred in concluding that plaintiffs' claims were completely preempted by federal law. Section 7422(a) precludes a suit for recovery of a federal tax alleged to be erroneously or illegally assessed or wrongfully collected unless a tax refund claim is filed with the IRS. It provides taxpayers with the means to obtain relief from improper collections by federal tax collectors while also protecting government collection officials from being sued by taxpayers. Although the so-called airline passenger excise tax cases applied the protections of Section 7422 to airlines that act as tax-collection agents for the IRS by collecting excise taxes from the sale of airplane tickets, "that expansive application does not extend to the present case because [FirstEnergy] did not collect or withhold any taxes," nor was it "acting as a collection agent for or on behalf of the IRS." (Id. at 8.)

Furthermore, the Sixth Circuit explicitly recognized that the "mere fact that the plaintiffs' damages are calculated in terms of overpaid income taxes does not necessitate the conclusion that the plaintiffs' claim must actually be one for a federal income tax refund. . . . This is especially so for the claim of state income taxes -- the plaintiffs' alleged overpayment of state income taxes obviously does not assert a federal income tax refund claim. Perhaps more to the point, however is that the plaintiffs are not seeking a tax refund inasmuch as they are not accusing the IRS of any wrongdoing. Under the plaintiffs' theory, the IRS was an innocent third-party who, like the plaintiffs themselves, merely relied on the 1099-DIVs issued by [FirstEnergy]." (Id., emphases in original.)

The district court ruled that the plaintiffs' state-law claims were completely preempted by the Internal Revenue Code. The doctrine of complete preemption applies where Congress intends the preemptive force of a federal statute to be so extraordinarily great that any state-law claim touching on the same field is deemed to be a federal claim arising under that federal law; in such circumstances, the federal statute provide the exclusive cause of action and the state-law claim is extinguished. See, e.g., Caterpillar, supra, 482 U.S. at 393. The Supreme Court has found complete preemption in only three classes of cases -- under Section 301 of the Labor Management Relations Act of 1947 (LMRA), 29 U.S.C. 185; the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1001-1461; and the National Bank Act, 12 U.S.C. 38. See Beneficial National Bank v. Anderson, supra, 539 U.S. at 7-9. The Supreme Court has not recognized complete preemption for damage claims alleging corporate misreporting to its taxpaying shareholders of their tax liability, nor under any other provision of the Internal Revenue Code. Indeed, the district court seemed to be the first court in the country to find complete preemption in the Internal Revenue Code. As the Mikulski panel noted, if the district court's analysis were correct, it would federalize most state law claims that remotely address tax issues, such as suing one's accountant or tax preparer.

So, after five years of federal litigation (four of which was on appeal), the Sixth Circuit is returning the Mikulski case back to the Ohio state court where it started in December 2001.

Which brings me back to the beginning of this post. What did the Sixth Circuit do in its en banc decision in Mikulski that was so extraordinarily rare? It affirmed the decision of the panel majority in all respects. This is extremely unusual because, out of all the en banc cases decided by the Sixth Circuit between January 2000 and the Mikulski rehearing in September 2006, the full Court has reversed the panel majority in every case except two: United States v. Koch, 383 F.3d 436 (2004), where the Court granted en banc review of the prior panel decision to consider whether the Supreme Court's decision in Blakely v. Washington, 542 U.S. 296 (2004), required the Court to invalidate the United States Sentencing Guidelines on Sixth Amendment grounds, and where the Court reinstated the judgment of the panel, adopted the panel opinion as its own, and added a further opinion regarding the validity of the Sentencing Guidelines; and Dotson v. Wilkinson, 329 F.3d 463 (6th Cir. 2003), where en banc review was granted to resolve a conflict among panels regarding state prisoner claims. Otherwise, as the active judges of the Sixth Circuit are currently constituted, the grant of rehearing en banc almost invariably means that the panel decision will be reversed in some significant respect.

Some other interesting facts about rehearings en banc in the Sixth Circuit are noteworthy. Chief Judge Boggs has been in the majority of every en banc decision since he became chief judge in 2004. In 2003 (the year before he became Chief), he voted with the majority of the more liberal judges of the Court in two out of three en banc cases. There are two identifiable groups of judges that vote together in all en banc cases. Judges Batchelder, Gibbons and Rogers have voted together in every en banc case. Similarly, Judges Martin, Daughtrey, Moore, Cole and Clay have sided with one another in every en banc decision, whether in the majority or in dissent. But the two groups have never voted the same way in any en banc case. It is too soon to draw extensive conclusions about the newer judges of the Court, Judges Sutton, Cook, McKeague and Griffin, but as "Bush 43" appointees, one may expect them to be reliably conservative and to vote most often with the Batchelder-Gibbons-Rogers bloc. Judge Gilman, and to a lesser extent Chief Judge Boggs, "swing" between the Court's liberal and conservative camps on a case-by-case basis, although Judge Gilman appears over time to vote increasingly frequently with his more conservative colleagues. I will have further observations and empirical information about the ideological voting patterns of the Sixth Circuit, particularly but not exclusively regarding the judges' bitter divisions in death penalty cases, in a future post.

Disclaimer: the author of this post (i) is one of the plaintiffs-appellants' counsel in Mikulski v. Centerior, and (ii) presented the oral argument for the petitioner-taxpayer to the Supreme Court in Grable.

Sunday, October 29, 2006

On December 6, 2006, the Sixth Circuit sitting en banc will hear arguments in an important election law case debating the precedential value of the Supreme Court's controversial 5-4 decision in Bush v. Gore, 531 U.S. 98 (2000)(per curiam), that decided the 2000 presidential election.

White and black voters in Summit and Sandusky Counties (in northern Ohio) and in Hamilton and Montgomery Counties (in southern Ohio) brought suit in the Northern District of Ohio for declaratory and injunctive relief, alleging inter alia that (i) the use of unreliable voting equipment (including punch card ballots) in some Ohio counties but not in others violated certain voters' rights under the Equal Protection Clause of the Fourteenth Amendment, and (ii) the use of punch card voting systems in Hamilton, Montgomery and Summit Counties had a disparate impact on African-American voters in violation of Section 2 of the Voting Rights Act of 1965.

In Stewart v. Blackwell,356 F. Supp.2d 791 (N.D. Ohio 2004), Judge Dowd found in favor of Defendants, Secretary of State (current candidate for Governor) Ken Blackwell and others, holding that (i) the use of punch card ballots in Hamilton, Montgomery and Summit Counties did not violate the Due Process Clause, the Equal Protection Clause or the Voting Rights Act, and (ii) the use of optical-scan technology to count votes in Sandusky County did not violate the equal protection rights of voters.

On April 21, 2006, a divided panel of the Sixth Circuit reversed, Stewart v. Blackwell, 444 F.3d 843 (6th Cir. 2006), with Judges Martin and Cole in the majority, holding that the selective use of unreliable punch card ballots in some Ohio counties violates the Equal Protection Clause under the holding of Bush v. Gore. Judge Gilman dissented, relying on a law review article by noted election law scholar Professor Richard L. Hasen, Bush vs. Gore and the Future of Equal Protection Law in Elections, 29 FSU L. Rev. 377 (2001), to conclude that Bush v. Gore should not be applied as valid precedent. The dissent applied the standard of Burdick v. Takushi, 504 U.S. 428 (1992), to find that there is no equal protection problem with the selective use of punch card voting procedures. On July 21, 2006, the Court vacated the panel opinion and granted en banc review.

Professor Hasen's posts on his blog, Election Law, regarding the panel opinion are here and here. His update when the Court granted rehearing en banc is here. Howard Bashman has another comment on the panel opinion in his blog How Appealing located here. Professor Dan Tokaji, co-counsel for the prevailing parties who made the oral argument to the panel, has this post at his Equal Vote blog.

Professor Hasen has stated that, if the Supreme Court were to take any Bush v. Gore-type cae in the near future, "it is likely to be Stewart v. Blackwell, if the en banc court reaches the same decision as the three-judge Sixth Circuit panel holding that the selective use of punch card ballots in only part of a jurisdiction violates equal protection under Bush v. Gore."

The en banc argument on December 6 will begin at 2:00 p.m. in Courtroom 403.

Saturday, July 15, 2006

Welcome to the Sixth Circuit Blog, a new web log devoted to appellate practice within the Sixth Circuit and in the highest courts of the four states it comprises. We intend to provide information, news and commentary regarding the cases on the Court's docket as well as monitoring key decisions and orders issued by and arguments presented to each court. We appreciate your interest in these matters and welcome your reactions, comments and contributions to what we hope will be the start of many lively discussions.

Our inaugural discussion concerns the cases in which the Sixth Circuit has recently ordered rehearings en banc. The first such case in which the Sixth Circuit has granted en banc rehearing examines the contours of federal question jurisdiction. In Mikulski v. Centerior Energy Corp., Case No. 03-4486, the issue is whether a single federal issue embedded in a claim for relief arising solely under state law is sufficient to invoke the section 1331 "arising under" jurisdiction of the federal courts.

The original panel majority held in January 2006 that no federal question jurisdiction existed in such circumstances, reversing the ruling of the Northern District of Ohio.

The Supplemental Brief filed by Appellants on the jurisdictional issue can be found here.

The Supreme Court's recent decision in Empire HealthChoice vs. McVeigh can be found here.